Investing money for the short-term is a necessity for many people.
Sometimes, an investor comes into a large chunk of money in the form of a bonus or winnings from the lottery. Other potential sources of chunky income could include maturing of an existing investment like a Unit Linked Insurance Plan (ULIP) or a Bond, or income from the sale of an investment like a house.
While you decide on a future course of action, you might want to park the money someplace. The moot idea here being that the money should be readily available when required and in the meantime, it should earn a reasonably good return. A Liquid Fund checks both boxes.
Let’s now answer some key questions regarding liquid funds.
What are Liquid funds?
Liquid Funds are debt mutual fund schemes that invest in bonds that mature in less than 91 days. These are open-ended schemes, meaning investors can subscribe to it on a continuous basis and the Net Asset Value (NAV) is declared daily. The aim of most liquid schemes is to ensure liquidity at all times and generate returns without compromising on the safety of capital. Fund managers of such schemes invest in short-term money market instruments like tri-party repo, commercial papers, treasury bills and other bonds that mature in 91 days or less.
Let us understand a few salient features of liquid funds:
- Liquidity and exit load
Since liquid funds are used by investors to invest money in the short-term, the focus is on maintaining the liquidity of a portfolio. Most of the investments made by a fund manager are liquid in nature. To enhance the liquidity of a portfolio, Securities & Exchange Board of India (SEBI), the capital market regulator, mandates investing at least 20% of money in liquid assets such as cash, government securities, treasury-bills and repo on government securities. Implementation of the same since June 30, 2020 has ensured that schemes’ portfolios are truly liquid.
Traditionally, liquid funds did not have exit loads or fees that investors have to pay when they exit the fund. However, SEBI introduced graded exit loads on investments in units of liquid funds in October 2019. The exit loads are as follows:
| Investor Exit Upon Subscription | Exit Load As a % of Redemption Proceeds |
| Day1 | 0.007 |
| Day2 | 0.0065 |
| Day3 | 0.006 |
| Day4 | 0.0055 |
| Day5 | 0.005 |
| Day6 | 0.0045 |
| Day7 | NIL |
For example, if an investor exits on day four, the proceeds will be subject to an exit load of 0.0055%. On the Seventh day onwards from the date of subscription, there is no exit load.
- Credit risk
Liquid fund schemes invest money in top-rated instruments. One rarely sees low-rated bonds in these schemes. However, in the credit crisis that unfolded in 2018-2019 some liquid funds were observed holding instruments which defaulted. Those defaults led to fall in net asset values (NAV) of units of some schemes and investors burnt their fingers. Since then, fund houses have become even more careful while investing in bonds.
Like any other debt fund, liquid funds’ portfolios are also valued on a mark-to-market basis. This is an accounting tool that records the asset’s value with respect to its current market price, ensures fair valuation of a portfolio and accounts for interest rate risk. Bonds are valued at their secondary market price. If interest rates go up, then bond prices go down. In a rising interest rate situation, this may cause some volatility in NAV. However, the impact of this volatility might be minimal because investors stay in schemes for seven days which evens out any negative impact of volatility. Fund managers also keep the duration – a measure of maturity of the bond portfolio at low levels, so that the volatility is contained.
Earlier, NAV of units of liquid funds were valued on amortization basis – a method which values bonds based on the fair values provided by valuation models, which may not be a true representation of the market values.
Liquid funds are also used as a source scheme for Systematic Transfer Plan (STP)– an arrangement to transfer money from one scheme to another, to invest in an equity scheme. Investors however, should be aware of exit loads while initiating an STP in an equity fund.
How does one invest in liquid funds?
Investments in liquid funds can be done through an intermediary (broker) like Upstox who is registered with Association of Mutual Funds in India (AMFI). These units can be bought and sold online as well as offline by filling up the form. Units are allotted to you only after realisation of funds by the asset management company. The cut-off time for purchase is 1:30 pm and for redemptions, the cut off time is 3 pm. In case of redemptions, money is paid out on the following business day.